Chapter 26 
                   
                  MONEY, BANKING, AND FINANCE 
                  Principles of Economics in Context (Goodwin et al) 
                  
                  
                  Chapter Overview 
                  
                  In this chapter, you will be introduced to a standard treatment of money and the banking 
                  system as well as the role that banks play in our financial system.  You will get an 
                  overview of the relationship between money and the average price level, and will learn 
                  about the role and functions of money, different types of money, and the concept of 
                  liquidity as it applies to money.  The chapter explores various types of banks and the 
                  role they play in money creation.  The functions of finance are introduced along with 
                  nonbank financial institutions.  The final section of the chapter presents a brief survey of 
                  financialization, financial asset bubbles, and the international financial sector (explored 
                  in detail in Chapter 29). 
                  
                  Objectives 
                  
                  After reading and reviewing this chapter, you should be able to: 
                   
                  1.  Describe the consequences of inflation and deflation. 
                  2.  Describe the functions and types of money. 
                  3.  Describe the measures of the money supply and explain the liquidity continuum. 
                  4.  Explain the basic workings of private banks including the use of balance sheets. 
                  5.  Explain how banks create money. 
                  6.  Describe the categories and functions of nonbank financial institutions. 
                  7.  Explain the concept of “financialization” and provide examples. 
                  8.  Explain the concept of “speculative bubble” and illustrate it with concrete examples. 
                  
                   Key Terms 
                    
                   barter                                         fractional reserve system 
                   deflation liquidity                            required reserves 
                   commodity money                                excess reserves 
                   intrinsic value                                portfolio investment 
                   fiat money                                     leverage 
                   exchange value                                 non-bank financial institution 
                   M1                                             collective investment vehicle 
                   M2                                             hedge fund 
                   financial                                      pension fund 
                   intermediary                                   insurance company 
                   Economic liability                             securities broker 
                   bank reserves                                  mortgage broker 
                   
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                  Active Review 
                  
                  Fill in the Blank 
                  
                     1.  The fact that money can be immediately used in exchange, whereas valuable 
                        jewelry cannot, illustrates the fact that money is very __________________. 
                      
                     2.  The measure of the money supply that includes currency in circulation, 
                        traveler’s checks, and checking accounts is called __________________. 
                      
                     3.  When the aggregate price level falls economists use the term ____________ 
                        to describe the situation. 
                      
                     4.  When something contains intrinsic value and also serves as a medium of 
                        exchange it is known as ____________________. 
                      
                     5.  The __________ definition of the money supply is broad enough to include 
                        savings deposits as well as checkable deposits and currency. 
                      
                     6.  A medium of exchange that is valuable because a government says that it has 
                        value is known as _______________. 
                      
                     7.  Institutions that accept funds and provide loans are known as 
                        _________________________. 
                      
                     8.  Vault cash and deposits at the Federal Reserve both count towards 
                        _____________, a term that describes funds not lent out or invested by a 
                        private bank. 
                      
                     9.  When banks are only required to hold a fraction of their deposits on reserve 
                        they are part of _________________________. 
                      
                     10. The portion of bank reserves that a bank must keep on reserve are known as 
                        _______________________. 
                      
                     11. The portion of bank reserves that banks are permitted to lend or invest are 
                        known as _______________________. 
                      
                     12. The use of debt to increase the potential rate of return on one’s own 
                        investment is called __________________. 
                      
                     13. One alternative to saving money in a bank is to use a ___________________ , 
                        which is a category of pooled funds. 
                      
                      
                      
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                     14. A _______________ is a type of pooled fund that often engages in highly 
                        speculative investments and is generally restricted to wealthy clients. 
                      
                     15. An agent responsible for finding a buyer for sellers of different securities is 
                        known as a ____________________. 
                  
                  
                  
                  True or False 
                  
                     16.  When a government finances its expenditures by printing money rather 
                        than collecting taxes, this can lead to “too much money chasing too few 
                        goods” and hyperinflation. 
                      
                     17.  Coins and paper money have in some periods been commodity money and in 
                        other periods fiat money. 
                      
                     18.  Nelson takes a $100 bill he had in his wallet and deposits it into his 
                        checking account.  Thus, M1 increases by $100. 
                      
                      
                      
                  Short Answer 
                  
                     19.  Why is inflation harmful to an economy? 
                      
                      
                      
                      
                      
                      
                     20.  Why is deflation harmful to an economy? 
                      
                      
                      
                      
                      
                      
                     21.  What are the three roles of money?  And what are two types of money? 
                      
                      
                      
                      
                      
                      
                  
                     22.  Identify the components of M1 and M2. 
                      
                      
                      
                      
                      
                      
                      
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                     23. Explain the difference between required reserves and excess reserves. 
                      
                      
                      
                      
                      
                      
                     24. Explain the difference between a commercial bank and an investment bank. 
                      
                      
                      
                      
                      
                      
                      
                     25.  What was the Glass-Steagall Act?  Why was it originally passed?  Why have some 
                         economists argued that elements of the Act should be restored? 
                      
                      
                      
                      
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